An Institutional Analysis of China’s Reform of their Monetary Policy Framework

Abstract

This article traces the history of China’s reform of its monetary policy framework and analyzes its success and problems. In the context of financial marketization and the failure of the quantity-targeting framework, the People’s Bank of China transformed its monetary policy framework toward one that targets interest rates. The reform includes two important institutional changes: establishing an interest rate corridor and decreasing the difficulty the Open Market Operations Room faces in estimating the market demand for reserves. The new monetary policy framework successfully stabilizes the interbank offered rate. However, this does not mean that the new framework is sufficient. One important problem remaining to be solved is how to manage the effects of fiscal activities on monetary policy operations. This article analyzes the fiscal effects on reserves in China’s Treasury Single Account system. The imperfect coordination mechanism between the Treasury and the central bank increases the difficulty for the central bank in achieving its interest rate target. A further reform is therefore needed to improve the coordination mechanism between the Treasury and the People’s Bank of China.